Uninsured Secondary Capital Accounts, 43789-43793 [05-14806]

Download as PDF Federal Register / Vol. 70, No. 145 / Friday, July 29, 2005 / Proposed Rules NATIONAL CREDIT UNION ADMINISTRATION 12 CFR Parts 701 and 741 Uninsured Secondary Capital Accounts National Credit Union Administration (NCUA). ACTION: Proposed rule. AGENCY: SUMMARY: The National Credit Union Administration (NCUA) seeks public comment on a proposal to allow lowincome designated credit unions that offer secondary capital accounts to begin redeeming the funds in those accounts when they are within five years of maturity, and to require prior approval of a plan for the use of secondary capital before such accounts can be offered. DATES: Comments must be received on or before September 27, 2005. ADDRESSES: You may submit comments by any one of the following methods (Please send comments by one method only): • Federal eRulemaking Portal: http:// www.regulations.gov. Follow the instructions for submitting comments. • NCUA Web Site: http:// www.ncua.gov/ RegulationsOpinionsLaws/ proposed_regs/proposed_regs.html. Follow the instructions for submitting comments. • E-mail: Address to regcomments@ncua.gov. Include ‘‘[Your name] Comments on Proposed Rule Part 701, Secondary Capital’’ in the e-mail subject line. • Fax: (703) 518–6319. Use the subject line described above for e-mail. • Mail: Address to Mary Rupp, Secretary of the Board, National Credit Union Administration, 1775 Duke Street, Alexandria, Virginia 22314– 3428. • Hand Delivery/Courier: Same as mail address. FOR FURTHER INFORMATION CONTACT: Steven W. Widerman, Trial Attorney, Office of General Counsel, at 703/518– 6557; or Margaret Miller, Program Officer, Office of Examination and Insurance, at 703/518–6375. SUPPLEMENTARY INFORMATION: A. Background of Uninsured Secondary Capital Accounts Authorization of Secondary Capital. The NCUA Board is authorized by law to permit credit unions serving predominantly low-income members to receive payments on shares from nonnatural persons under conditions the Board sets. 12 U.S.C. 1757(6). In 1996, VerDate jul<14>2003 17:15 Jul 28, 2005 Jkt 205001 the NCUA Board amended section 701.34 of its rules and regulations to authorize low-income designated credit unions (‘‘LICUs’’),1 including Statechartered credit unions to the extent permitted by State law, to offer uninsured secondary capital (‘‘SC’’) accounts to non-natural person members and nonmembers. 12 CFR 701.34(b). The accounts were intended to provide LICUs a further means— beyond setting aside a portion of income—to build capital in order to serve two purposes: To support greater lending and financial services in their communities, and to absorb losses and prevent the credit union from failing. 61 FR 3788 (Feb. 2, 1996). To ensure the safety and soundness of the LICUs that offered SC accounts, and to ensure that the accounts serve the intended purposes, existing section 701.34(b) imposes a variety of conditions. 61 FR at 3788. These conditions apply to State-chartered LICUs as well. 12 CFR 741.204. A LICU may offer SC accounts only after submitting a written plan for the use and repayment of the accounts. § 701.34(b)(1). The accounts must be established as uninsured, non-share instruments. § 701.34(b)(2) and (5). They must have a minimum maturity of 5 years and may not be redeemable prior to maturity. § 701.34(b)(3)–(4). An account holder’s claim against an offering LICU must be subordinate to all other claims of shareholders, creditors and the Share Insurance Fund. § 701.34(b)(6). And most importantly, SC funds on deposit (including interest paid into the account) must be available to cover losses in excess of the LICU’s net available reserves and undivided earnings. § 701.34(b)(7). The funds used to cover such losses may not be replenished or restored to the SC account. Id. Net Worth Value. Beginning at 5 years remaining maturity, existing § 701.34(c)(1) requires an offering LICU to discount the capital value (now called ‘‘net worth value’’) of its SC accounts at the rate of 20 percent per year. The purpose of discounting the net worth value is: To discourage overreliance on SC accounts to cover future operating losses; to encourage LICUs to continually replenish their sources of maturing SC; and to facilitate 1 The NCUA Board is authorized by law to define ‘‘credit unions serving predominantly low-income members.’’ 12 U.S.C. 1757(6). To be so designated by the appropriate Regional Director, the NCUA Board generally requires the majority of a credit union’s members to earn less than 80 percent of the average national wage as determined by the Bureau of Labor Statistics, or to have annual household incomes below the national median as determined by the Census Bureau. 12 CFR 701.34(a)(2)–(3). PO 00000 Frm 00004 Fmt 4702 Sfmt 4702 43789 net worth growth to support the expansion of lending and financial services in their communities. 61 FR at 3788, 3789. Even as its capital value is discounted, however, the full amount of SC on deposit remains available to cover losses. § 701.34(c)(2). Prompt Corrective Action. In 2000, pursuant to Congressional mandate, NCUA adopted a system of ‘‘prompt corrective action’’ (‘‘PCA’’) consisting of mandatory minimum capital standards indexed by a credit union’s ‘‘net worth ratio’’ to five statutory net worth categories.2 12 U.S.C. 1790d; 12 CFR 702; 65 FR 8560 (Feb. 18, 2000). A credit union whose net worth ratio puts it in the top category, ‘‘well capitalized’’, is essentially free of PCA. But as a credit union’s net worth ratio falls and its classification among the net worth categories declines below ‘‘well capitalized,’’ it is exposed to an expanding range of mandatory and discretionary supervisory actions designed to restore net worth. E.g., 12 CFR 702.201(a), 702.202(a), 702.204(b). Effect on LICUs. The original purpose of discounting the net worth value of SC beginning at 5 years remaining remains vital today. Under PCA, however, the requirement to do so reduces a LICU’s net worth ratio. While the ‘‘net worth’’ side of the ratio is discounted at the rate of 20 percent annually, the ‘‘assets’’ side of the ratio must remain the same because, as currently written, § 701.34(b) prohibits the redemption of SC accounts prior to maturity. § 701.34(b)(4). Redeeming SC accounts would correct the imbalance between the ‘‘net worth’’ and ‘‘assets’’ sides of the ratio. Without the ability to redeem SC accounts, discounting net worth value will dilute a LICU’s net worth ratio, possibly causing its classification among the net worth categories to fall and triggering further PCA. A significant number of LICUs are exposed to the possibility that discounting the value of their SC will dilute their net worth ratio. December 2004 Call Report data shows that 55 of the 1019 LICUs offer SC accounts. These accounts have an aggregate balance of $19.7 million. The number of LICUs offering SC accounts has remained relatively stable in recent years. Of the 55 LICUs presently offering SC accounts, 48 are classified ‘‘well capitalized’’ and 4 are classified ‘‘adequately capitalized,’’ indicating that 95 percent currently have net worth 2 The ‘‘net worth’’ of a LICU is defined as its retained earnings per GAAP plus any SC. 12 U.S.C. 1790d(o)(2); 12 CFR 702.2(f). The ‘‘net worth ratio’’ of a credit union is the ratio of its net worth to its total assets. 12 U.S.C. 1790d(o)(3); 12 CFR 702.2(g) and (k). E:\FR\FM\29JYP1.SGM 29JYP1 43790 Federal Register / Vol. 70, No. 145 / Friday, July 29, 2005 / Proposed Rules ratios that subject them to little or no PCA. A principal purpose of this rule is to prevent the discounting of SC from diluting the net worth of LICUs that offer SC accounts. B. Proposed Modifications to Existing Section 701.34 1. Redemption of Secondary Capital Existing § 701.34(b)(4) prohibits a LICU from redeeming SC accounts at any time prior to their maturity. As explained above, however, the requirement to discount SC threatens to dilute a LICU’s net worth ratio if it cannot also redeem the SC no longer recognized as net worth (‘‘discounted SC’’) at the same time. To protect LICUs from this threat, the proposed rule adds new subsection (d) permitting LICU’s to redeem discounted SC under certain conditions, and eliminates the restriction on redemption in existing § 701.34(b). Approval to Redeem. To redeem SC, the proposed rule requires a LICU to first obtain the approval of the appropriate Regional Director (‘‘RD’’). If the LICU is State-chartered, the proposed rule adds a new subsection (d) to § 741.204, requiring the approval of the appropriate State Supervisory Authority (‘‘SSA’’) with the concurrence of the RD. A request to redeem must be submitted in writing for each year preceding maturity (unless the RD indicates in writing that the approval is for more than one year). If, within 45 days of the RD’s receipt of its request to redeem, a LICU is not notified of the RD’s and/or SSA’s decision on the request, the LICU may proceed with the proposed redemption. To obtain approval to redeem, the following redemption risks must be addressed: First, the LICU must show sufficient post-redemption net worth to be ‘‘well capitalized.’’ See note 2 supra. Being classified in the top net worth category frees a credit union of PCA. But as soon as net worth declines below ‘‘well capitalized,’’ PCA forces that credit union to start rebuilding net worth by making quarterly transfers of earnings to net worth. 12 CFR 702.201(a). If not ‘‘well capitalized,’’ however, a LICU that is ‘‘adequately capitalized’’ may seek RD approval to redeem, which will be granted or denied on a case-by-case basis (provided the other redemption criteria below are met). Second, the SC funds to be redeemed must have been on deposit for at least two years. This requirement only affects SC having a 5-year maturity; SC with a maturity greater than 5 years is ineligible for redemption. LICUs VerDate jul<14>2003 17:15 Jul 28, 2005 Jkt 205001 generally incorporate the receipt of SC into their long-term business plans and financial budgets. Allowing a LICU to redeem that SC within the first two years can impair its ability to implement its strategic and business plans, and to achieve its budget objectives and financial stability. For example, a LICU’s business plan might call for a rapid and substantial expansion of products and services offered to members. In turn, the expenses associated with this expansion, including loan losses, could increase accordingly. Without a track record of the expenses these products and services entail, it is impossible to accurately project the full extent of these expenses; it can only be estimated. The purpose of the 2-year waiting period is to allow the actual expenses to be realized and to permit the expansion of products and services to stabilize. The track record that develops during that period will show the extent to which discounted SC may be needed to absorb the expenses and thus should not be redeemed. Third, the LICU must demonstrate that the SC funds to be redeemed will not be needed to cover losses prior to maturity of the account. As previously noted, an essential feature of SC is its availability to cover operating losses in excess of net worth. For this reason, a redemption request should be denied when there is a reasonable expectation that discounted SC will be needed to cover post-redemption operating losses occurring prior to maturity of the account. Fourth, the LICU must demonstrate that its books and records are current and reconciled. The purpose of this requirement is straightforward: To make sure the RD who is evaluating a redemption request has complete, accurate and up to date financial data to assess the LICU’s financial condition and to verify its compliance with full and fair disclosure requirements. Fifth, the LICU must identify any other funding that might be affected by the redemption of SC. For example, the Department of the Treasury’s Community Development Financial Institutions (‘‘CDFI’’) Fund may provide a LICU funding in the form of SC subject to a contractual condition that the LICU raise and hold matching SC from another source. If the LICU redeems the matching SC, it may be contractually required to redeem an equal measure of CDFI funding. Non-SC matching nonmember deposits and grants also may be similarly impacted if SC is redeemed prior to maturity. Finally, the request for approval to redeem must be authorized by a PO 00000 Frm 00005 Fmt 4702 Sfmt 4702 resolution of the LICU’s board of directors. A board resolution documents that a majority of the board participated in a board decision. Maximum board member participation in deciding to redeem SC helps to overcome possible conflicts of interest between LICU officials and officials of the SC account holder. Schedule for Redemption. For redemption requests that are approved, the proposed rule prescribes a schedule for redeeming SC accounts that is reciprocal to existing § 701.34(b)’s schedule for recognizing the net worth value of those accounts: Remaining maturity Four to less than five years .. Three to less than four years Two to less than three years One to less than two years .. Redemption limit (percent) 20 40 60 80 To the extent a proportion of SC is no longer recognized as net worth under the existing net worth recognition schedule, that same proportion may be redeemed under the redemption schedule. For example, when between ‘‘four to less than five years’’ remain until maturity, 80 percent of value of the account is recognized as net worth, meaning that 20 percent is not. See § 701.34(c)(1)(i). As the schedule above shows, the proposed rule allows the LICU to redeem the 20 percent that is no longer recognized as net worth. The last year of remaining maturity is omitted from the schedule because the maturity of the account effectively redeems the remaining SC. Balancing net worth recognition with redemption of SC protects a LICU’s net worth ratio from being diluted. 2. Approval of Plan for Use of Secondary Capital Existing § 701.34(b) requires a LICU seeking to offer SC accounts to ‘‘adopt, and forward to the appropriate Regional Director, a written plan for the use of the funds’’ in those accounts and ‘‘subsequent liquidity needs’’ to repay them upon maturity. § 701.34(b)(1). In the case of a LICU that is Statechartered, that plan must be submitted to both the RD and the SSA. 12 CFR 741.204(c). But in neither case do the existing rules require an SC plan to be approved before a LICU can offer SC accounts. Inappropriate Use of Secondary Capital. In practice, SC sometimes is not used to achieve the goals for which it was conceived, i.e. building capital to support expansion of lending and financial services in LICUs’ E:\FR\FM\29JYP1.SGM 29JYP1 Federal Register / Vol. 70, No. 145 / Friday, July 29, 2005 / Proposed Rules communities, and serving as a cushion against losses. 61 FR 3788 (Feb. 2, 1996). Between 1999 and 2004, twentyeight LICUs that offer SC accounts have been liquidated or merged, forcing the Share Insurance Fund to step in and absorb losses in nine cases. SC played a role in masking the magnitude of other problems (such as inefficient operations leading to an unreasonably high ratio of net operating expenses to assets, and inadequate underwriting) that led to most of these liquidations. To ensure safe and sound use of SC, the proposed rule requires prior approval—not just submission—of a LICU’s SC plan, and establishes evaluation criteria for such plans. Evaluation and Approval of Plan. The proposed rule revises existing § 701.34(b)(1) to require RD approval of the written SC plan that a LICU presently must submit before offering SC accounts. In the case of a Statechartered LICU, the rule revises § 741.204(c) to require SSA approval of the SC plan with the concurrence of the RD. Approval will be required only for plans submitted on or after the effective date of a final rule; existing SC plans will not be affected. If, within 45 days of an RD’s receipt of an SC plan submitted for approval, a LICU is not notified of the RD’s and/or SSA’s decision on the plan, the LICU may proceed to offer SC accounts pursuant to the plan. The proposed rule adds two more evaluation criteria to the two that existing § 701.34(b)(1) already prescribes for an SC plan (i.e., what the SC will be used for and how it will be repaid when the accounts mature): It must demonstrate that the proposed use of SC conforms to the offering LICU’s strategic plan, business plan and budget; and it must be supported by accompanying pro forma financial statements, including any off-balance sheet items, covering a minimum of the next two years. The purpose of these criteria is to project and document the future financial performance of the LICU in relation to the risks associated with offering SC accounts. 3. Clarification of Disclosure Requirements Existing § 701.34(b)(11) requires that a ‘‘Disclosure and Acknowledgment’’ form ‘‘as set forth in the Appendix to this section be provided to and executed by’’ the SC account investor. The form recites the key terms and regulatory limitations that distinguish SC accounts (e.g., that they are uninsured, subordinate to all other claims, and available to cover operating losses in excess of net worth) as well as the VerDate jul<14>2003 17:15 Jul 28, 2005 Jkt 205001 individual terms of each investment (e.g., investor’s name, amount, term, how accrued interest is to be paid). The purpose of the form is to make sure ‘‘there is no misunderstanding on the part of the investors as to the nature of the accounts and the risks involved.’’ 61 FR at 3788. Proof of Disclosure. In many cases, the parties may see only a reprint or facsimile of the Appendix containing the ‘‘Disclosure and Acknowledgment’’ form without referring to § 701.34(b)(11), which clearly says who must sign it. But the Appendix itself does not specify who must sign the form—an official of the institutional investor or an official of the offering LICU—or require that person to date the form to show when it was provided to the investor. This ambiguity and lack of a date has led to misunderstandings, if not disputes, about when, if at all, the nature of SC accounts and the risks involved were disclosed to institutional investors. A credit union official’s signature on the form is no proof that the investor ever got the form, let alone when. And without a date, the signature of an institutional investor’s official proves the form was received, but not when— before or after the funds were deposited in the SC account—thus failing to document that the investor was informed of the terms, limitations and risks before investing.3 The proposed rule rectifies this problem simply by including at the bottom of the form a signature block specifically for an official of the institutional investor that reads: ‘‘ACKNOWLEDGED AND AGREED TO this lll day of (month and year) by (name of investor’s official, name of investor, address and phone number of investor, and investor’s tax identification number).’’ Option to Redeem. Consistent with new subsection (d) allowing SC accounts to be redeemed, the proposed rule eliminates the ‘‘Disclosure and Acknowledgment’’ form’s provision barring redemption prior to maturity. To also ensure that the option to redeem SC accounts remains with the offering LICU throughout, the proposed rule goes a step further, adding a provision to the form stating that SC accounts are ‘‘redeemable only at the option of the offering credit union.’’ This will prevent 3 Existing § 701.34(b)(10) requires the parties to execute a ‘‘contract agreement * * * accurately establishing the terms and conditions of this section and containing no provisions inconsistent therewith.’’ In practice, however, it is unclear that such contracts consistently and reliably do that— all the more reason that investors should receive the ‘‘Disclosure and Acknowledgement’’ before investing in an SC account. PO 00000 Frm 00006 Fmt 4702 Sfmt 4702 43791 LICUs and their institutional investors from agreeing by contract in advance of making an SC investment that the LICU will redeem it later on regardless of what circumstances may arise afterward. 4. Other Modifications Apart from the substantive modifications explained above, the proposed rule makes several conforming and clarifying adjustments to existing § 701.34. The references to ‘‘reserves and undivided earnings’’ in existing § 701.34(b)(7) and the corresponding provision of the Appendix have been changed to ‘‘net worth’’ to reflect the adoption of that term pursuant to PCA. See 12 U.S.C. 1790d(o)(2). Existing §§ 701.34(b)(12) and (13) have been combined in a single, abbreviated section explaining the PCA authority to prohibit payment of principal, interest and dividends on SC accounts established after August 7, 2000. Finally, the ‘‘scale’’ used in existing § 701.34(c)(1) to recognize the capital value of SC accounts has been converted to schedule form to match the form of the corresponding redemption schedule in new subsection (d). Regulatory Procedures Regulatory Flexibility Act The Regulatory Flexibility Act requires NCUA to prepare an analysis describing any significant economic impact a proposed regulation may have on a substantial number of small credit unions (those having under $10 million in assets). The proposed rule allows credit unions to redeem secondary capital accounts when they are within five years of maturity, without imposing any additional regulatory burden. If adopted, the proposed rule will not have a significant economic impact on a substantial number of small credit unions. Thus, a Regulatory Flexibility Analysis is not required. Paperwork Reduction Act NCUA has determined that the proposed rule would not increase paperwork requirements under the Paperwork Reduction Act of 1995 and regulations of the Office of Management and Budget. Executive Order 13132 Executive Order 13132 encourages independent regulatory agencies to consider the impact of their regulatory actions on State and local interests. NCUA, an independent regulatory agency as defined in 44 U.S.C. 3502(5), voluntarily adheres to the fundamental federalism principles addressed by the executive order. This proposed rule E:\FR\FM\29JYP1.SGM 29JYP1 43792 Federal Register / Vol. 70, No. 145 / Friday, July 29, 2005 / Proposed Rules would not have a substantial direct effect on the States, on the relationship between the national government and the States, or on the distribution of power and responsibilities among the various levels of government. Accordingly, this proposed rule does not constitute a policy that has federalism implications for purposes of the Executive Order. Treasury and General Government Appropriations Act, 1999 NCUA has determined that the proposed rule will not affect family well-being within the meaning of section 654 of the Treasury and General Appropriations Act, 1999, Pub. L. 105– 277, 112 Stat. 2681 (1998). Agency Regulatory Goal NCUA’s goal is to promulgate clear, understandable regulations that impose a minimal regulatory burden. The proposed rule seeks to improve and simplify the existing rule on uninsured secondary capital accounts. We request your comments on whether the proposed rule would be understandable and minimally intrusive if implemented as proposed. List of Subjects in 12 CFR Parts 701 and 741 Bank deposit insurance, Credit Unions, Reporting and recordkeeping requirements. By the National Credit Union Administration Board on July 21, 2005. Mary F. Rupp, Secretary of the Board. For the reasons set forth above, 12 CFR parts 701 and 741 are proposed to be amended as follows: PART 701—ORGANIZATION AND OPERATIONS OF FEDERAL CREDIT UNIONS 1. The authority citation for part 701 continues to read as follows: Authority: 12 U.S.C. 1752(5), 1755, 1756, 1757, 1759, 1761a, 1761b, 1766, 1767, 1782, 1784, 1787, 1789 and Public Law 101–73. Section 701.6 is also authorized by 31 U.S.C. 3717. Section 701.31 is also authorized by 12 U.S.C. 1601 et seq., 42 U.S.C. 1981 and 42 U.S.C. 3601–3610. Section 701.35 is also authorized by 12 U.S.C. 4311–4312. 2. Amend § 701.34 as follows: a. Revise the section heading to read as set forth below; b. Revise paragraphs (b) and (c) to read as set forth below; c. Add new paragraph (d) before the Appendix to § 701.34 to read as set forth below; and VerDate jul<14>2003 17:15 Jul 28, 2005 Jkt 205001 d. Revise the Appendix to § 701.34 following new paragraph (d) to read as follows: § 701.34 Designation of low income status; Offering of secondary capital accounts by low-income designated credit unions. * * * * * (b) Offering of secondary capital accounts by low-income designated credit unions. A Federal credit union having a designation of low-income status pursuant to paragraph (a) of this section may offer secondary capital accounts to nonnatural person members and nonnatural person nonmembers subject to the following conditions: (1) Secondary capital plan. Prior to offering secondary capital accounts, the credit union shall adopt, and forward to the appropriate NCUA Regional Director for approval, a written ‘‘secondary capital plan’’ that, at a minimum: (i) Identifies the purpose(s) for which secondary capital will be used; and how it will be repaid; (ii) Explains how the credit union will provide for subsequent liquidity to repay secondary capital upon maturity of the accounts; (iii) Demonstrates that the planned uses of secondary capital conform to the offering credit union’s strategic plan, business plan and budget; and (iv) Includes supporting pro forma financial statements including any offbalance sheet items, covering a minimum of the next two years. (2) Decision on plan. If a LICU is not notified within 45 days of receipt of a secondary capital plan that the plan is approved or disapproved, the LICU may proceed to offer secondary capital accounts pursuant to the plan. (3) Nonshare account. The secondary capital account must be established as an uninsured secondary capital account or other form of non-share account. (4) Minimum maturity. The maturity of the secondary capital account must be a minimum of five years. (5) Uninsured account. The secondary capital account shall not be insured by the National Credit Union Share Insurance Fund or any governmental or private entity. (6) Subordination of claim. The secondary capital account holder’s claim against the credit union must be subordinate to all other claims including those of shareholders, creditors and the National Credit Union Share Insurance Fund. (7) Availability to cover losses. Funds deposited into the secondary capital account, including interest accrued and paid into the secondary capital account, must be available to cover operating losses realized by the credit union that PO 00000 Frm 00007 Fmt 4702 Sfmt 4702 exceed its net available net worth (exclusive of secondary capital and allowance accounts for loan and lease losses), and to the extent funds are so used, the credit union shall under no circumstances restore or replenish the account. The credit union may, in lieu of paying interest into the secondary capital account, pay interest accrued on the secondary capital account directly to the investor or into a separate account from which the secondary capital investor may make withdrawals. Losses shall be distributed pro-rata among all secondary capital accounts held by the credit union at the time the losses are realized. (8) Security. The secondary capital account may not be pledged or provided by the account-holder as security on a loan or other obligation with the credit union or any other party. (9) Merger or dissolution. In the event of merger or other voluntary dissolution of the credit union, other than merger into another low-income designated credit union, the secondary capital accounts will, to the extent they are not needed to cover losses at the time of merger or dissolution, be closed and paid out to the account-holder. (10) Contract agreement. A secondary capital account contract agreement must be executed by an authorized representative of the account holder and the credit union, accurately establishing the terms and conditions of this section and containing no provisions inconsistent therewith. (11) Disclosure and acknowledgement. A ‘‘Disclosure and Acknowledgment’’ as set forth in the Appendix to this section must be executed by an authorized representative of the offering credit union and of the secondary capital account holder at the time of entering into the account agreement. An original of the account agreement and the ‘‘Disclosure and Acknowledgment’’ must be retained by the credit union for the term of the agreement, and a copy must be provided to the account holder. (12) Prompt corrective action. As provided in §§ 702.204(b)(11), 702.304(b) and 702.305(b) of this chapter, the NCUA Board may prohibit a credit union classified ‘‘critically undercapitalized’’ or a ‘‘new’’ credit union classified ‘‘moderately capitalized’’, ‘‘marginally capitalized’’, ‘‘minimally capitalized’’ or ‘‘uncapitalized’’, as the case may be, from paying principal, dividends or interest on its uninsured secondary capital accounts established after August 7, 2000, except that unpaid dividends or interest shall continue to E:\FR\FM\29JYP1.SGM 29JYP1 Federal Register / Vol. 70, No. 145 / Friday, July 29, 2005 / Proposed Rules accrue under the terms of the account to the extent permitted by law. (c) Accounting treatment; Recognition of net worth value of accounts. (1) Equity account. A low-income designated credit union that issues secondary capital accounts pursuant to paragraph (b) of this section shall record the funds on its balance sheet in an equity account entitled ‘‘uninsured secondary capital account.’’ (2) Schedule for recognizing net worth value. For such accounts with remaining maturities of less than five years, the credit union shall reflect the net worth value of the accounts in its financial statement in accordance with the following schedule: Remaining maturity Recognized net worth value (percent) Four to less than five years .. Three to less than four years Two to less than three years One to less than two years .. Less than one year ............... 80 60 40 20 0 (3) Financial statement. The credit union will reflect the full amount of the secondary capital on deposit in a footnote to its financial statement. (d) Redemption of secondary capital. With the written approval of the appropriate Regional Director, secondary capital that is not recognized as net worth under paragraph (c)(2) of this section (‘‘discounted secondary capital’’) may be redeemed according to the remaining maturity schedule in paragraph (d)(3) of the section. (1) Request to redeem secondary capital. A request for approval to redeem discounted secondary capital must be submitted in writing on an annual basis and must demonstrate to the satisfaction of the appropriate Regional Director that: (i) The offering credit union is classified ‘‘well capitalized’’ under part 702 of this chapter, provided however, that a Regional Director may, on a caseby-case basis, permit an ‘‘adequately capitalized’’ credit union that meets the other criteria in this paragraph to redeem discounted secondary capital; (ii) The discounted secondary capital has been on deposit at least two years; (iii) The discounted secondary capital will not be needed to cover losses prior to final maturity of the account; (iv) The offering credit union’s books and records are current and reconciled; (v) The proposed redemption will not jeopardize other current sources of funding, if any, to the offering credit union; and VerDate jul<14>2003 17:15 Jul 28, 2005 Jkt 205001 (vi) The request to redeem is authorized by resolution of the offering credit union’s board of directors. (2) Decision on request. If a LICU is not notified within 45 days of receipt of a request for approval to redeem secondary capital that its request is either granted or denied, the LICU may proceed to redeem secondary capital accounts as proposed. (3) Schedule for redeeming secondary capital. Remaining maturity Redemption limit (percent) Four to less than five years .. Three to less than four years Two to less than three years One to less than two years .. 20 40 60 80 Appendix to § 701.34 A credit union that is authorized to offer uninsured secondary capital accounts and each investor in such an account shall execute and date the following ‘‘Disclosure and Acknowledgment’’ form, a signed original of which shall be retained by the credit union: Disclosure and Acknowledgment (Name of CU) and (Name of investor) hereby acknowledge and agree that (Name of investor) has committed (amount of funds) to a secondary capital account with (name of credit union) under the following terms and conditions: 1. The funds committed to the secondary capital account are committed for a period of __ years. 2. Subject to the conditions set forth in 12 CFR 701.34, the funds committed to the secondary capital account are redeemable only at the option of the offering credit union and only with the prior approval of the appropriate regional director. 3. The secondary capital account is not a share account and the funds committed to the secondary capital account are not insured by the National Credit Union Share Insurance Fund or any other governmental or private entity. 4. The funds committed to the secondary capital account and any interest paid into the account may be used by (name of credit union) to cover any and all operating losses that exceed the credit union’s net worth exclusive of allowance accounts for loan losses, and in the event the funds are so used (name of credit union) will under no circumstances restore or replenish those funds to (name of institutional investor). 5. By initialing below, (name of credit union) and (name of institutional investor) agree that accrued interest will be: __ Paid into and become part of the secondary capital account; __ Paid directly to the investor; __ Paid into a separate account from which the investor may make withdrawals; or __ Any combination of the above provided the details are specified and agreed to in writing. PO 00000 Frm 00008 Fmt 4702 Sfmt 4702 43793 6. In the event of liquidation of (name of credit union), the funds committed to the secondary capital account shall be subordinate to all other claims on the assets of the credit union, including claims of member shareholders, creditors and the National Credit Union Share Insurance Fund. 7. Under certain net worth classifications (see 12 CFR 702.204(b)(11), 702.304(b) and 702.305(b), as the case may be), the NCUA Board may prohibit (name of credit union) from paying principal, dividends or interest on its uninsured secondary capital accounts established after August 7, 2000, except that unpaid dividends or interest shall continue to accrue under the terms of the account to the extent permitted by law. ACKNOWLEDGED AND AGREED TO by this ___ day of (month and year) by: lllllllllllllllllllll (name of investor’s official) (title of official) (name of investor) (address and phone number of investor) (investor’s tax identification number) PART 741—REQUIREMENTS FOR INSURANCE 1. The authority citation for part 741 continues to read as follows: Authority: 12 U.S.C. 1757, 1766, 1781– 1790, and 1790d. Section 741.4 is also authorized by 31 U.S.C. 3717. 2. Amend § 741.204 as follows: a. Remove from paragraph (c) the citation ‘‘§ 701.34’’ and add in its place the citation ‘‘§ 701.34(b)(1)’’; b. Add at the end of paragraph (c) after ‘‘Regional Director’’ the words: ‘‘for approval. The state supervisory authority shall approve or disapprove the plan with the concurrence of the appropriate NCUA Regional Director.’’ c. Add new paragraph (d) to read as follows: § 741.204 Maximum public unit and nonmember accounts, and low income designation. * * * * * (d) Redeem secondary capital accounts only in accordance with the terms and conditions authorized for Federal credit unions pursuant to § 701.34(d) of this chapter and to the extent not inconsistent with applicable state law and regulation. State chartered federally insured credit unions seeking to redeem secondary capital accounts must submit the request required by § 701.34(d)(1) to both the state supervisory authority and the NCUA Regional Director. The state supervisory authority shall grant or deny the request with the concurrence of the appropriate NCUA Regional Director. [FR Doc. 05–14806 Filed 7–28–05; 8:45 am] BILLING CODE 7535–01–P E:\FR\FM\29JYP1.SGM 29JYP1

Agencies

[Federal Register Volume 70, Number 145 (Friday, July 29, 2005)]
[Proposed Rules]
[Pages 43789-43793]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 05-14806]



[[Page 43789]]

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NATIONAL CREDIT UNION ADMINISTRATION

12 CFR Parts 701 and 741


Uninsured Secondary Capital Accounts

AGENCY: National Credit Union Administration (NCUA).

ACTION: Proposed rule.

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SUMMARY: The National Credit Union Administration (NCUA) seeks public 
comment on a proposal to allow low-income designated credit unions that 
offer secondary capital accounts to begin redeeming the funds in those 
accounts when they are within five years of maturity, and to require 
prior approval of a plan for the use of secondary capital before such 
accounts can be offered.

DATES: Comments must be received on or before September 27, 2005.

ADDRESSES: You may submit comments by any one of the following methods 
(Please send comments by one method only):
     Federal eRulemaking Portal: http://www.regulations.gov. 
Follow the instructions for submitting comments.
     NCUA Web Site: http://www.ncua.gov/
RegulationsOpinionsLaws/proposed_regs/proposed_regs.html. Follow the 
instructions for submitting comments.
     E-mail: Address to regcomments@ncua.gov. Include ``[Your 
name] Comments on Proposed Rule Part 701, Secondary Capital'' in the e-
mail subject line.
     Fax: (703) 518-6319. Use the subject line described above 
for e-mail.
     Mail: Address to Mary Rupp, Secretary of the Board, 
National Credit Union Administration, 1775 Duke Street, Alexandria, 
Virginia 22314-3428.
     Hand Delivery/Courier: Same as mail address.

FOR FURTHER INFORMATION CONTACT: Steven W. Widerman, Trial Attorney, 
Office of General Counsel, at 703/518-6557; or Margaret Miller, Program 
Officer, Office of Examination and Insurance, at 703/518-6375.

SUPPLEMENTARY INFORMATION:

A. Background of Uninsured Secondary Capital Accounts

    Authorization of Secondary Capital. The NCUA Board is authorized by 
law to permit credit unions serving predominantly low-income members to 
receive payments on shares from non-natural persons under conditions 
the Board sets. 12 U.S.C. 1757(6). In 1996, the NCUA Board amended 
section 701.34 of its rules and regulations to authorize low-income 
designated credit unions (``LICUs''),\1\ including State-chartered 
credit unions to the extent permitted by State law, to offer uninsured 
secondary capital (``SC'') accounts to non-natural person members and 
nonmembers. 12 CFR 701.34(b). The accounts were intended to provide 
LICUs a further means--beyond setting aside a portion of income--to 
build capital in order to serve two purposes: To support greater 
lending and financial services in their communities, and to absorb 
losses and prevent the credit union from failing. 61 FR 3788 (Feb. 2, 
1996).
---------------------------------------------------------------------------

    \1\ The NCUA Board is authorized by law to define ``credit 
unions serving predominantly low-income members.'' 12 U.S.C. 
1757(6). To be so designated by the appropriate Regional Director, 
the NCUA Board generally requires the majority of a credit union's 
members to earn less than 80 percent of the average national wage as 
determined by the Bureau of Labor Statistics, or to have annual 
household incomes below the national median as determined by the 
Census Bureau. 12 CFR 701.34(a)(2)-(3).
---------------------------------------------------------------------------

    To ensure the safety and soundness of the LICUs that offered SC 
accounts, and to ensure that the accounts serve the intended purposes, 
existing section 701.34(b) imposes a variety of conditions. 61 FR at 
3788. These conditions apply to State-chartered LICUs as well. 12 CFR 
741.204. A LICU may offer SC accounts only after submitting a written 
plan for the use and repayment of the accounts. Sec.  701.34(b)(1). The 
accounts must be established as uninsured, non-share instruments. Sec.  
701.34(b)(2) and (5). They must have a minimum maturity of 5 years and 
may not be redeemable prior to maturity. Sec.  701.34(b)(3)-(4). An 
account holder's claim against an offering LICU must be subordinate to 
all other claims of shareholders, creditors and the Share Insurance 
Fund. Sec.  701.34(b)(6). And most importantly, SC funds on deposit 
(including interest paid into the account) must be available to cover 
losses in excess of the LICU's net available reserves and undivided 
earnings. Sec.  701.34(b)(7). The funds used to cover such losses may 
not be replenished or restored to the SC account. Id.
    Net Worth Value. Beginning at 5 years remaining maturity, existing 
Sec.  701.34(c)(1) requires an offering LICU to discount the capital 
value (now called ``net worth value'') of its SC accounts at the rate 
of 20 percent per year. The purpose of discounting the net worth value 
is: To discourage overreliance on SC accounts to cover future operating 
losses; to encourage LICUs to continually replenish their sources of 
maturing SC; and to facilitate net worth growth to support the 
expansion of lending and financial services in their communities. 61 FR 
at 3788, 3789. Even as its capital value is discounted, however, the 
full amount of SC on deposit remains available to cover losses. Sec.  
701.34(c)(2).
    Prompt Corrective Action. In 2000, pursuant to Congressional 
mandate, NCUA adopted a system of ``prompt corrective action'' 
(``PCA'') consisting of mandatory minimum capital standards indexed by 
a credit union's ``net worth ratio'' to five statutory net worth 
categories.\2\ 12 U.S.C. 1790d; 12 CFR 702; 65 FR 8560 (Feb. 18, 2000). 
A credit union whose net worth ratio puts it in the top category, 
``well capitalized'', is essentially free of PCA. But as a credit 
union's net worth ratio falls and its classification among the net 
worth categories declines below ``well capitalized,'' it is exposed to 
an expanding range of mandatory and discretionary supervisory actions 
designed to restore net worth. E.g., 12 CFR 702.201(a), 702.202(a), 
702.204(b).
---------------------------------------------------------------------------

    \2\ The ``net worth'' of a LICU is defined as its retained 
earnings per GAAP plus any SC. 12 U.S.C. 1790d(o)(2); 12 CFR 
702.2(f). The ``net worth ratio'' of a credit union is the ratio of 
its net worth to its total assets. 12 U.S.C. 1790d(o)(3); 12 CFR 
702.2(g) and (k).
---------------------------------------------------------------------------

    Effect on LICUs. The original purpose of discounting the net worth 
value of SC beginning at 5 years remaining remains vital today. Under 
PCA, however, the requirement to do so reduces a LICU's net worth 
ratio. While the ``net worth'' side of the ratio is discounted at the 
rate of 20 percent annually, the ``assets'' side of the ratio must 
remain the same because, as currently written, Sec.  701.34(b) 
prohibits the redemption of SC accounts prior to maturity. Sec.  
701.34(b)(4). Redeeming SC accounts would correct the imbalance between 
the ``net worth'' and ``assets'' sides of the ratio. Without the 
ability to redeem SC accounts, discounting net worth value will dilute 
a LICU's net worth ratio, possibly causing its classification among the 
net worth categories to fall and triggering further PCA.
    A significant number of LICUs are exposed to the possibility that 
discounting the value of their SC will dilute their net worth ratio. 
December 2004 Call Report data shows that 55 of the 1019 LICUs offer SC 
accounts. These accounts have an aggregate balance of $19.7 million. 
The number of LICUs offering SC accounts has remained relatively stable 
in recent years. Of the 55 LICUs presently offering SC accounts, 48 are 
classified ``well capitalized'' and 4 are classified ``adequately 
capitalized,'' indicating that 95 percent currently have net worth

[[Page 43790]]

ratios that subject them to little or no PCA. A principal purpose of 
this rule is to prevent the discounting of SC from diluting the net 
worth of LICUs that offer SC accounts.

B. Proposed Modifications to Existing Section 701.34

1. Redemption of Secondary Capital

    Existing Sec.  701.34(b)(4) prohibits a LICU from redeeming SC 
accounts at any time prior to their maturity. As explained above, 
however, the requirement to discount SC threatens to dilute a LICU's 
net worth ratio if it cannot also redeem the SC no longer recognized as 
net worth (``discounted SC'') at the same time. To protect LICUs from 
this threat, the proposed rule adds new subsection (d) permitting 
LICU's to redeem discounted SC under certain conditions, and eliminates 
the restriction on redemption in existing Sec.  701.34(b).
    Approval to Redeem. To redeem SC, the proposed rule requires a LICU 
to first obtain the approval of the appropriate Regional Director 
(``RD''). If the LICU is State-chartered, the proposed rule adds a new 
subsection (d) to Sec.  741.204, requiring the approval of the 
appropriate State Supervisory Authority (``SSA'') with the concurrence 
of the RD. A request to redeem must be submitted in writing for each 
year preceding maturity (unless the RD indicates in writing that the 
approval is for more than one year). If, within 45 days of the RD's 
receipt of its request to redeem, a LICU is not notified of the RD's 
and/or SSA's decision on the request, the LICU may proceed with the 
proposed redemption.
    To obtain approval to redeem, the following redemption risks must 
be addressed:
    First, the LICU must show sufficient post-redemption net worth to 
be ``well capitalized.'' See note 2 supra. Being classified in the top 
net worth category frees a credit union of PCA. But as soon as net 
worth declines below ``well capitalized,'' PCA forces that credit union 
to start rebuilding net worth by making quarterly transfers of earnings 
to net worth. 12 CFR 702.201(a). If not ``well capitalized,'' however, 
a LICU that is ``adequately capitalized'' may seek RD approval to 
redeem, which will be granted or denied on a case-by-case basis 
(provided the other redemption criteria below are met).
    Second, the SC funds to be redeemed must have been on deposit for 
at least two years. This requirement only affects SC having a 5-year 
maturity; SC with a maturity greater than 5 years is ineligible for 
redemption. LICUs generally incorporate the receipt of SC into their 
long-term business plans and financial budgets. Allowing a LICU to 
redeem that SC within the first two years can impair its ability to 
implement its strategic and business plans, and to achieve its budget 
objectives and financial stability. For example, a LICU's business plan 
might call for a rapid and substantial expansion of products and 
services offered to members. In turn, the expenses associated with this 
expansion, including loan losses, could increase accordingly. Without a 
track record of the expenses these products and services entail, it is 
impossible to accurately project the full extent of these expenses; it 
can only be estimated. The purpose of the 2-year waiting period is to 
allow the actual expenses to be realized and to permit the expansion of 
products and services to stabilize. The track record that develops 
during that period will show the extent to which discounted SC may be 
needed to absorb the expenses and thus should not be redeemed.
    Third, the LICU must demonstrate that the SC funds to be redeemed 
will not be needed to cover losses prior to maturity of the account. As 
previously noted, an essential feature of SC is its availability to 
cover operating losses in excess of net worth. For this reason, a 
redemption request should be denied when there is a reasonable 
expectation that discounted SC will be needed to cover post-redemption 
operating losses occurring prior to maturity of the account.
    Fourth, the LICU must demonstrate that its books and records are 
current and reconciled. The purpose of this requirement is 
straightforward: To make sure the RD who is evaluating a redemption 
request has complete, accurate and up to date financial data to assess 
the LICU's financial condition and to verify its compliance with full 
and fair disclosure requirements.
    Fifth, the LICU must identify any other funding that might be 
affected by the redemption of SC. For example, the Department of the 
Treasury's Community Development Financial Institutions (``CDFI'') Fund 
may provide a LICU funding in the form of SC subject to a contractual 
condition that the LICU raise and hold matching SC from another source. 
If the LICU redeems the matching SC, it may be contractually required 
to redeem an equal measure of CDFI funding. Non-SC matching nonmember 
deposits and grants also may be similarly impacted if SC is redeemed 
prior to maturity.
    Finally, the request for approval to redeem must be authorized by a 
resolution of the LICU's board of directors. A board resolution 
documents that a majority of the board participated in a board 
decision. Maximum board member participation in deciding to redeem SC 
helps to overcome possible conflicts of interest between LICU officials 
and officials of the SC account holder.
    Schedule for Redemption. For redemption requests that are approved, 
the proposed rule prescribes a schedule for redeeming SC accounts that 
is reciprocal to existing Sec.  701.34(b)'s schedule for recognizing 
the net worth value of those accounts:

------------------------------------------------------------------------
                                                            Redemption
                   Remaining maturity                          limit
                                                             (percent)
------------------------------------------------------------------------
Four to less than five years............................              20
Three to less than four years...........................              40
Two to less than three years............................              60
One to less than two years..............................              80
------------------------------------------------------------------------

    To the extent a proportion of SC is no longer recognized as net 
worth under the existing net worth recognition schedule, that same 
proportion may be redeemed under the redemption schedule. For example, 
when between ``four to less than five years'' remain until maturity, 80 
percent of value of the account is recognized as net worth, meaning 
that 20 percent is not. See Sec.  701.34(c)(1)(i). As the schedule 
above shows, the proposed rule allows the LICU to redeem the 20 percent 
that is no longer recognized as net worth. The last year of remaining 
maturity is omitted from the schedule because the maturity of the 
account effectively redeems the remaining SC. Balancing net worth 
recognition with redemption of SC protects a LICU's net worth ratio 
from being diluted.

2. Approval of Plan for Use of Secondary Capital

    Existing Sec.  701.34(b) requires a LICU seeking to offer SC 
accounts to ``adopt, and forward to the appropriate Regional Director, 
a written plan for the use of the funds'' in those accounts and 
``subsequent liquidity needs'' to repay them upon maturity. Sec.  
701.34(b)(1). In the case of a LICU that is State-chartered, that plan 
must be submitted to both the RD and the SSA. 12 CFR 741.204(c). But in 
neither case do the existing rules require an SC plan to be approved 
before a LICU can offer SC accounts.
    Inappropriate Use of Secondary Capital. In practice, SC sometimes 
is not used to achieve the goals for which it was conceived, i.e. 
building capital to support expansion of lending and financial services 
in LICUs'

[[Page 43791]]

communities, and serving as a cushion against losses. 61 FR 3788 (Feb. 
2, 1996). Between 1999 and 2004, twenty-eight LICUs that offer SC 
accounts have been liquidated or merged, forcing the Share Insurance 
Fund to step in and absorb losses in nine cases. SC played a role in 
masking the magnitude of other problems (such as inefficient operations 
leading to an unreasonably high ratio of net operating expenses to 
assets, and inadequate underwriting) that led to most of these 
liquidations. To ensure safe and sound use of SC, the proposed rule 
requires prior approval--not just submission--of a LICU's SC plan, and 
establishes evaluation criteria for such plans.
    Evaluation and Approval of Plan. The proposed rule revises existing 
Sec.  701.34(b)(1) to require RD approval of the written SC plan that a 
LICU presently must submit before offering SC accounts. In the case of 
a State-chartered LICU, the rule revises Sec.  741.204(c) to require 
SSA approval of the SC plan with the concurrence of the RD. Approval 
will be required only for plans submitted on or after the effective 
date of a final rule; existing SC plans will not be affected. If, 
within 45 days of an RD's receipt of an SC plan submitted for approval, 
a LICU is not notified of the RD's and/or SSA's decision on the plan, 
the LICU may proceed to offer SC accounts pursuant to the plan.
    The proposed rule adds two more evaluation criteria to the two that 
existing Sec.  701.34(b)(1) already prescribes for an SC plan (i.e., 
what the SC will be used for and how it will be repaid when the 
accounts mature): It must demonstrate that the proposed use of SC 
conforms to the offering LICU's strategic plan, business plan and 
budget; and it must be supported by accompanying pro forma financial 
statements, including any off-balance sheet items, covering a minimum 
of the next two years. The purpose of these criteria is to project and 
document the future financial performance of the LICU in relation to 
the risks associated with offering SC accounts.

3. Clarification of Disclosure Requirements

    Existing Sec.  701.34(b)(11) requires that a ``Disclosure and 
Acknowledgment'' form ``as set forth in the Appendix to this section be 
provided to and executed by'' the SC account investor. The form recites 
the key terms and regulatory limitations that distinguish SC accounts 
(e.g., that they are uninsured, subordinate to all other claims, and 
available to cover operating losses in excess of net worth) as well as 
the individual terms of each investment (e.g., investor's name, amount, 
term, how accrued interest is to be paid). The purpose of the form is 
to make sure ``there is no misunderstanding on the part of the 
investors as to the nature of the accounts and the risks involved.'' 61 
FR at 3788.
    Proof of Disclosure. In many cases, the parties may see only a 
reprint or facsimile of the Appendix containing the ``Disclosure and 
Acknowledgment'' form without referring to Sec.  701.34(b)(11), which 
clearly says who must sign it. But the Appendix itself does not specify 
who must sign the form--an official of the institutional investor or an 
official of the offering LICU--or require that person to date the form 
to show when it was provided to the investor. This ambiguity and lack 
of a date has led to misunderstandings, if not disputes, about when, if 
at all, the nature of SC accounts and the risks involved were disclosed 
to institutional investors.
    A credit union official's signature on the form is no proof that 
the investor ever got the form, let alone when. And without a date, the 
signature of an institutional investor's official proves the form was 
received, but not when--before or after the funds were deposited in the 
SC account--thus failing to document that the investor was informed of 
the terms, limitations and risks before investing.\3\ The proposed rule 
rectifies this problem simply by including at the bottom of the form a 
signature block specifically for an official of the institutional 
investor that reads: ``ACKNOWLEDGED AND AGREED TO this ------ day of 
(month and year) by (name of investor's official, name of investor, 
address and phone number of investor, and investor's tax identification 
number).''
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    \3\ Existing Sec.  701.34(b)(10) requires the parties to execute 
a ``contract agreement * * * accurately establishing the terms and 
conditions of this section and containing no provisions inconsistent 
therewith.'' In practice, however, it is unclear that such contracts 
consistently and reliably do that--all the more reason that 
investors should receive the ``Disclosure and Acknowledgement'' 
before investing in an SC account.
---------------------------------------------------------------------------

    Option to Redeem. Consistent with new subsection (d) allowing SC 
accounts to be redeemed, the proposed rule eliminates the ``Disclosure 
and Acknowledgment'' form's provision barring redemption prior to 
maturity. To also ensure that the option to redeem SC accounts remains 
with the offering LICU throughout, the proposed rule goes a step 
further, adding a provision to the form stating that SC accounts are 
``redeemable only at the option of the offering credit union.'' This 
will prevent LICUs and their institutional investors from agreeing by 
contract in advance of making an SC investment that the LICU will 
redeem it later on regardless of what circumstances may arise 
afterward.

4. Other Modifications

    Apart from the substantive modifications explained above, the 
proposed rule makes several conforming and clarifying adjustments to 
existing Sec.  701.34. The references to ``reserves and undivided 
earnings'' in existing Sec.  701.34(b)(7) and the corresponding 
provision of the Appendix have been changed to ``net worth'' to reflect 
the adoption of that term pursuant to PCA. See 12 U.S.C. 1790d(o)(2). 
Existing Sec. Sec.  701.34(b)(12) and (13) have been combined in a 
single, abbreviated section explaining the PCA authority to prohibit 
payment of principal, interest and dividends on SC accounts established 
after August 7, 2000. Finally, the ``scale'' used in existing Sec.  
701.34(c)(1) to recognize the capital value of SC accounts has been 
converted to schedule form to match the form of the corresponding 
redemption schedule in new subsection (d).

Regulatory Procedures

Regulatory Flexibility Act

    The Regulatory Flexibility Act requires NCUA to prepare an analysis 
describing any significant economic impact a proposed regulation may 
have on a substantial number of small credit unions (those having under 
$10 million in assets). The proposed rule allows credit unions to 
redeem secondary capital accounts when they are within five years of 
maturity, without imposing any additional regulatory burden. If 
adopted, the proposed rule will not have a significant economic impact 
on a substantial number of small credit unions. Thus, a Regulatory 
Flexibility Analysis is not required.

Paperwork Reduction Act

    NCUA has determined that the proposed rule would not increase 
paperwork requirements under the Paperwork Reduction Act of 1995 and 
regulations of the Office of Management and Budget.

Executive Order 13132

    Executive Order 13132 encourages independent regulatory agencies to 
consider the impact of their regulatory actions on State and local 
interests. NCUA, an independent regulatory agency as defined in 44 
U.S.C. 3502(5), voluntarily adheres to the fundamental federalism 
principles addressed by the executive order. This proposed rule

[[Page 43792]]

would not have a substantial direct effect on the States, on the 
relationship between the national government and the States, or on the 
distribution of power and responsibilities among the various levels of 
government. Accordingly, this proposed rule does not constitute a 
policy that has federalism implications for purposes of the Executive 
Order.

Treasury and General Government Appropriations Act, 1999

    NCUA has determined that the proposed rule will not affect family 
well-being within the meaning of section 654 of the Treasury and 
General Appropriations Act, 1999, Pub. L. 105-277, 112 Stat. 2681 
(1998).

Agency Regulatory Goal

    NCUA's goal is to promulgate clear, understandable regulations that 
impose a minimal regulatory burden. The proposed rule seeks to improve 
and simplify the existing rule on uninsured secondary capital accounts. 
We request your comments on whether the proposed rule would be 
understandable and minimally intrusive if implemented as proposed.

List of Subjects in 12 CFR Parts 701 and 741

    Bank deposit insurance, Credit Unions, Reporting and recordkeeping 
requirements.

    By the National Credit Union Administration Board on July 21, 
2005.
Mary F. Rupp,
Secretary of the Board.

    For the reasons set forth above, 12 CFR parts 701 and 741 are 
proposed to be amended as follows:

PART 701--ORGANIZATION AND OPERATIONS OF FEDERAL CREDIT UNIONS

    1. The authority citation for part 701 continues to read as 
follows:

    Authority: 12 U.S.C. 1752(5), 1755, 1756, 1757, 1759, 1761a, 
1761b, 1766, 1767, 1782, 1784, 1787, 1789 and Public Law 101-73. 
Section 701.6 is also authorized by 31 U.S.C. 3717. Section 701.31 
is also authorized by 12 U.S.C. 1601 et seq., 42 U.S.C. 1981 and 42 
U.S.C. 3601-3610. Section 701.35 is also authorized by 12 U.S.C. 
4311-4312.

    2. Amend Sec.  701.34 as follows:
    a. Revise the section heading to read as set forth below;
    b. Revise paragraphs (b) and (c) to read as set forth below;
    c. Add new paragraph (d) before the Appendix to Sec.  701.34 to 
read as set forth below; and
    d. Revise the Appendix to Sec.  701.34 following new paragraph (d) 
to read as follows:


Sec.  701.34  Designation of low income status; Offering of secondary 
capital accounts by low-income designated credit unions.

* * * * *
    (b) Offering of secondary capital accounts by low-income designated 
credit unions. A Federal credit union having a designation of low-
income status pursuant to paragraph (a) of this section may offer 
secondary capital accounts to nonnatural person members and nonnatural 
person nonmembers subject to the following conditions:
    (1) Secondary capital plan. Prior to offering secondary capital 
accounts, the credit union shall adopt, and forward to the appropriate 
NCUA Regional Director for approval, a written ``secondary capital 
plan'' that, at a minimum:
    (i) Identifies the purpose(s) for which secondary capital will be 
used; and how it will be repaid;
    (ii) Explains how the credit union will provide for subsequent 
liquidity to repay secondary capital upon maturity of the accounts;
    (iii) Demonstrates that the planned uses of secondary capital 
conform to the offering credit union's strategic plan, business plan 
and budget; and
    (iv) Includes supporting pro forma financial statements including 
any off-balance sheet items, covering a minimum of the next two years.
    (2) Decision on plan. If a LICU is not notified within 45 days of 
receipt of a secondary capital plan that the plan is approved or 
disapproved, the LICU may proceed to offer secondary capital accounts 
pursuant to the plan.
    (3) Nonshare account. The secondary capital account must be 
established as an uninsured secondary capital account or other form of 
non-share account.
    (4) Minimum maturity. The maturity of the secondary capital account 
must be a minimum of five years.
    (5) Uninsured account. The secondary capital account shall not be 
insured by the National Credit Union Share Insurance Fund or any 
governmental or private entity.
    (6) Subordination of claim. The secondary capital account holder's 
claim against the credit union must be subordinate to all other claims 
including those of shareholders, creditors and the National Credit 
Union Share Insurance Fund.
    (7) Availability to cover losses. Funds deposited into the 
secondary capital account, including interest accrued and paid into the 
secondary capital account, must be available to cover operating losses 
realized by the credit union that exceed its net available net worth 
(exclusive of secondary capital and allowance accounts for loan and 
lease losses), and to the extent funds are so used, the credit union 
shall under no circumstances restore or replenish the account. The 
credit union may, in lieu of paying interest into the secondary capital 
account, pay interest accrued on the secondary capital account directly 
to the investor or into a separate account from which the secondary 
capital investor may make withdrawals. Losses shall be distributed pro-
rata among all secondary capital accounts held by the credit union at 
the time the losses are realized.
    (8) Security. The secondary capital account may not be pledged or 
provided by the account-holder as security on a loan or other 
obligation with the credit union or any other party.
    (9) Merger or dissolution. In the event of merger or other 
voluntary dissolution of the credit union, other than merger into 
another low-income designated credit union, the secondary capital 
accounts will, to the extent they are not needed to cover losses at the 
time of merger or dissolution, be closed and paid out to the account-
holder.
    (10) Contract agreement. A secondary capital account contract 
agreement must be executed by an authorized representative of the 
account holder and the credit union, accurately establishing the terms 
and conditions of this section and containing no provisions 
inconsistent therewith.
    (11) Disclosure and acknowledgement. A ``Disclosure and 
Acknowledgment'' as set forth in the Appendix to this section must be 
executed by an authorized representative of the offering credit union 
and of the secondary capital account holder at the time of entering 
into the account agreement. An original of the account agreement and 
the ``Disclosure and Acknowledgment'' must be retained by the credit 
union for the term of the agreement, and a copy must be provided to the 
account holder.
    (12) Prompt corrective action. As provided in Sec. Sec.  
702.204(b)(11), 702.304(b) and 702.305(b) of this chapter, the NCUA 
Board may prohibit a credit union classified ``critically 
undercapitalized'' or a ``new'' credit union classified ``moderately 
capitalized'', ``marginally capitalized'', ``minimally capitalized'' or 
``uncapitalized'', as the case may be, from paying principal, dividends 
or interest on its uninsured secondary capital accounts established 
after August 7, 2000, except that unpaid dividends or interest shall 
continue to

[[Page 43793]]

accrue under the terms of the account to the extent permitted by law.
    (c) Accounting treatment; Recognition of net worth value of 
accounts.
    (1) Equity account. A low-income designated credit union that 
issues secondary capital accounts pursuant to paragraph (b) of this 
section shall record the funds on its balance sheet in an equity 
account entitled ``uninsured secondary capital account.''
    (2) Schedule for recognizing net worth value. For such accounts 
with remaining maturities of less than five years, the credit union 
shall reflect the net worth value of the accounts in its financial 
statement in accordance with the following schedule:

------------------------------------------------------------------------
                                                          Recognized net
                   Remaining maturity                       worth value
                                                             (percent)
------------------------------------------------------------------------
Four to less than five years............................              80
Three to less than four years...........................              60
Two to less than three years............................              40
One to less than two years..............................              20
Less than one year......................................               0
------------------------------------------------------------------------

    (3) Financial statement. The credit union will reflect the full 
amount of the secondary capital on deposit in a footnote to its 
financial statement.
    (d) Redemption of secondary capital. With the written approval of 
the appropriate Regional Director, secondary capital that is not 
recognized as net worth under paragraph (c)(2) of this section 
(``discounted secondary capital'') may be redeemed according to the 
remaining maturity schedule in paragraph (d)(3) of the section.
    (1) Request to redeem secondary capital. A request for approval to 
redeem discounted secondary capital must be submitted in writing on an 
annual basis and must demonstrate to the satisfaction of the 
appropriate Regional Director that:
    (i) The offering credit union is classified ``well capitalized'' 
under part 702 of this chapter, provided however, that a Regional 
Director may, on a case-by-case basis, permit an ``adequately 
capitalized'' credit union that meets the other criteria in this 
paragraph to redeem discounted secondary capital;
    (ii) The discounted secondary capital has been on deposit at least 
two years;
    (iii) The discounted secondary capital will not be needed to cover 
losses prior to final maturity of the account;
    (iv) The offering credit union's books and records are current and 
reconciled;
    (v) The proposed redemption will not jeopardize other current 
sources of funding, if any, to the offering credit union; and
    (vi) The request to redeem is authorized by resolution of the 
offering credit union's board of directors.
    (2) Decision on request. If a LICU is not notified within 45 days 
of receipt of a request for approval to redeem secondary capital that 
its request is either granted or denied, the LICU may proceed to redeem 
secondary capital accounts as proposed.
    (3) Schedule for redeeming secondary capital.

------------------------------------------------------------------------
                                                            Redemption
                   Remaining maturity                          limit
                                                             (percent)
------------------------------------------------------------------------
Four to less than five years............................              20
Three to less than four years...........................              40
Two to less than three years............................              60
One to less than two years..............................              80
------------------------------------------------------------------------

Appendix to Sec.  701.34

    A credit union that is authorized to offer uninsured secondary 
capital accounts and each investor in such an account shall execute 
and date the following ``Disclosure and Acknowledgment'' form, a 
signed original of which shall be retained by the credit union:

Disclosure and Acknowledgment

    (Name of CU) and (Name of investor) hereby acknowledge and agree 
that (Name of investor) has committed (amount of funds) to a 
secondary capital account with (name of credit union) under the 
following terms and conditions:
    1. The funds committed to the secondary capital account are 
committed for a period of ---- years.
    2. Subject to the conditions set forth in 12 CFR 701.34, the 
funds committed to the secondary capital account are redeemable only 
at the option of the offering credit union and only with the prior 
approval of the appropriate regional director.
    3. The secondary capital account is not a share account and the 
funds committed to the secondary capital account are not insured by 
the National Credit Union Share Insurance Fund or any other 
governmental or private entity.
    4. The funds committed to the secondary capital account and any 
interest paid into the account may be used by (name of credit union) 
to cover any and all operating losses that exceed the credit union's 
net worth exclusive of allowance accounts for loan losses, and in 
the event the funds are so used (name of credit union) will under no 
circumstances restore or replenish those funds to (name of 
institutional investor).
    5. By initialing below, (name of credit union) and (name of 
institutional investor) agree that accrued interest will be:
    ---- Paid into and become part of the secondary capital account;
    ---- Paid directly to the investor;
    ---- Paid into a separate account from which the investor may 
make withdrawals; or
    ---- Any combination of the above provided the details are 
specified and agreed to in writing.
    6. In the event of liquidation of (name of credit union), the 
funds committed to the secondary capital account shall be 
subordinate to all other claims on the assets of the credit union, 
including claims of member shareholders, creditors and the National 
Credit Union Share Insurance Fund.
    7. Under certain net worth classifications (see 12 CFR 
702.204(b)(11), 702.304(b) and 702.305(b), as the case may be), the 
NCUA Board may prohibit (name of credit union) from paying 
principal, dividends or interest on its uninsured secondary capital 
accounts established after August 7, 2000, except that unpaid 
dividends or interest shall continue to accrue under the terms of 
the account to the extent permitted by law.

ACKNOWLEDGED AND AGREED TO by this ------ day of (month and year) 
by:
-----------------------------------------------------------------------

(name of investor's official)
(title of official)
(name of investor)
(address and phone number of investor)
(investor's tax identification number)

PART 741--REQUIREMENTS FOR INSURANCE

    1. The authority citation for part 741 continues to read as 
follows:

    Authority: 12 U.S.C. 1757, 1766, 1781-1790, and 1790d. Section 
741.4 is also authorized by 31 U.S.C. 3717.

    2. Amend Sec.  741.204 as follows:
    a. Remove from paragraph (c) the citation ``Sec.  701.34'' and add 
in its place the citation ``Sec.  701.34(b)(1)'';
    b. Add at the end of paragraph (c) after ``Regional Director'' the 
words: ``for approval. The state supervisory authority shall approve or 
disapprove the plan with the concurrence of the appropriate NCUA 
Regional Director.''
    c. Add new paragraph (d) to read as follows:


Sec.  741.204  Maximum public unit and nonmember accounts, and low 
income designation.

* * * * *
    (d) Redeem secondary capital accounts only in accordance with the 
terms and conditions authorized for Federal credit unions pursuant to 
Sec.  701.34(d) of this chapter and to the extent not inconsistent with 
applicable state law and regulation. State chartered federally insured 
credit unions seeking to redeem secondary capital accounts must submit 
the request required by Sec.  701.34(d)(1) to both the state 
supervisory authority and the NCUA Regional Director. The state 
supervisory authority shall grant or deny the request with the 
concurrence of the appropriate NCUA Regional Director.

[FR Doc. 05-14806 Filed 7-28-05; 8:45 am]
BILLING CODE 7535-01-P